Home > Competitiveness concerns: Should US climate policy include border measures?

Border measures in US climate policy options

Jisun Kim, Gary Hufbauer17 October 2008

US climate change policy seems likely to include border measures to address competitiveness concerns. This column warns against such measures, arguing that they will do little to protect US industries, expose the US to retaliatory trade restrictions, and significantly burden the global trading system. The US would be better served by addressing its competitiveness concerns in international negotiations.

Due to rising domestic and international pressures, several greenhouse gas (GHG) control bills have been introduced in the 110th Congress. Some states and regional groups have already enacted controls. Whether US climate policy[1] takes the form of a carbon tax, a cap-and-trade system, performance standards, or some other method, serious greenhouse gas controls are likely to impose heavy costs on the US economy, concentrated in a small number of GHG-intensive industries and activities.

The prospect of heavy costs has raised concerns about the competitive position of US producers and the “leakage” of production and jobs to foreign firms. In the absence of parallel international commitments, US measures might shift manufacturing activity to China and India, among other countries that do not equivalently limit carbon emissions. If that happened, US controls might make little difference to global climate change since emissions activity would simply migrate abroad. To address these concerns, at the federal level, US legislators have drafted special provisions in their GHG control bills such as free allocation of allowances, special exemptions, and border adjustments[2] that would affect both US exports to and imports from countries that do not have comparable climate policies.1

Will trade measures work for the United States?

Trade-related rules, such as an emissions allowance requirement imposed on foreign producers at the US border, have gained political support, both because they address the competitiveness issue and because they arguably create incentives for other countries to join in combating climate change. The logic of this approach is clear. However, it is questionable whether trade measures will achieve the goals sought. Moreover, it is quite possible that trade measures, if imposed by several major countries, will adversely affect the US.

The US imports carbon-intensive goods largely from Canada and the EU, which emit less CO2 than the US (see Figure 1).

China and India, the primary targets of US trade measures, are not large suppliers of carbon-intensive exports to the US. This implies two things. First, trade measures may not provide intended economic relief to domestic industries affected adversely by US climate change policy because US firms are competing mostly with “cleaner” countries. Second, US trade measures may not create substantial leverage to shape climate change policies of other countries – particularly China and India – even though they could provoke retaliation that hits US exports.

In proposed US legislation, trade measures would be imposed on imports unless the trading partner enacts domestic climate policy “comparable” to US policy. However, the largest foreign suppliers to the US of carbon-intensive goods are countries like Canada and the EU, and these countries emit considerably less carbon than the US, on both a national and per capita basis. Moreover, the EU has already enacted more stringent greenhouse gas measures than the US, and Canada may soon do the same. “Comparability” tests imposed by the US could be turned around by other countries – starting with the EU – -to implement similar measures against imports from the US. This sort of escalation would damage both US exporters and the world trading system.

A round of global trade restrictions, enacted in the name of climate change, would interrupt the agenda of trade liberalisation that has proven enormously successful in boosting world economic growth since World War II. The damage to the world economy would be severe. Recall that trade barriers were a hallmark of the Great Depression. Wall Street collapsed first; Smoot-Hawley was passed second.

Will trade measures pass muster under the WTO?

While the WTO allows member countries great flexibility in adopting environmental standards within their territories, the same discretion does not apply in their trading relations with other countries. Accordingly, trade barriers have the potential to conflict with WTO rules. In light of economic history, WTO rules that limit national actions should be counted as a blessing.

To be specific, GHG trade measures mixed with mechanisms designed to alleviate the burden of emission controls on domestic firms may collide with WTO rules. If the US enacts its own unique brand of import bans, border taxes, and comparability mechanisms, disputes are likely to arise under the core WTO provisions such as GATT Articles I (most-favoured-nations), II (tariff schedules), III (national treatment), and XI (quotas).2 Trade measures that violate those core WTO provisions may seek justification under the exceptions of GATT Article XX, but the probable consequence will be a drawn-out period of trade skirmishes, possibly escalating to trade wars.

One way to determine whether new trade measures in support of greenhouse gas emission controls are compatible with WTO agreements is to let the dispute settlement process run its course. In the end, a record of decided cases will define the contours of WTO obligations. However, given the complications and sensitivity of GHG controls, the Appellate Body is unlikely to produce clear guidelines for several years. Moreover, consigning these decisions to a panel of jurists would put tremendous stress on the WTO dispute settlement system.

Looking ahead

A central issue in designing US climate change policy is how to level the playing field internationally. Given uncertainties in their effectiveness and possible conflicts with WTO rules, the flowering of national trade measures and their resolution by WTO panels may not offer the best approach. Given the fact that large emitting countries – notably China and India – are also under domestic and international pressures, the US might better address competitiveness concerns by actively engaging in international negotiations. Two forums for international engagement are relevant: Copenhagen and the WTO.

Upcoming negotiations in Copenhagen, to be concluded in December 2009, are aimed at agreeing on a post-Kyoto regime. Importantly, both the US and China – -which are not only the largest sources of GHG emissions, but the cause of great concern over the outcome of climate negotiations – are expected to join the international regime. While the post-Kyoto compact may not reach agreement on uniform international standards, American and Chinese engagement will build significant momentum, which could draw stronger commitments from India and other developing countries. In this way, the US may partly address its own competitiveness concerns.

While the post-Kyoto regime will probably announce new ambitious targets for reducing carbon emissions and commit both developing and developed countries to take action, national governments will likely be left to their own methods for meeting targets. Under this scenario, conflicts due to difference in climate change policies are all but certain. Rather than consign the crucial decisions to the WTO judicial system, key WTO members should attempt to write a new WTO Code of Good Practice on GHG rules. The idea would be to define more sharply the policy space for climate control measures that are consistent with core WTO principles, even if a technical violation of WTO law might occur. To encourage WTO negotiating efforts along these lines, the US and other important emitting countries should adopt time-limited “peace clauses” in their own national climate legislation. The “peace clauses” should suspend the application of border measures or other extra-territorial controls for a defined period of time (say three years) while WTO negotiations are underway. In our opinion, these negotiations should be on the WTO’s priority agenda for 2009.

Footnotes

1 State and regional controls are only beginning to grapple with “leakage “and competitive questions.